While catching up on some reading I missed during the holidays, I stumbled upon this article in Barron’s talking about potentially overvalued food chains. I had been looking into Darden Restaurants (DRI) after its share price was slaughtered in the wake of its second-quarter earnings release, and I decided to look into the casual-plus dining chains a little further. After doing some research, I have to ask the question: Why in the world would anyone buy BJ's Restaurants (BJRI) when they could buy Darden?
First, a quick glance at the two companies' valuations. DRI trades at 8.2x trailing EV/EBITDA and ~12.5x forward earnings. BJRI trades at 17.75x trailing EV/EBITDA and 36.35x forward earnings. Those are pretty ripe numbers for any company, but especially for a casual chain concept in the notoriously fierce restaurant industry. Here’s another interesting way to look at it: At current prices, you are paying about $4.5m for each DRI restaurant (slightly more than it currently takes to build them) and about $10.4m for each BJRI restaurant.
Let’s take a deeper dive into the company’s finances. BJRI has earned $11.1m, $12.9m, $13.4m, $13.4m, and $19.7m in EBIT over the past five years. This year, it’ll earn somewhere around $27m. Those are gaudy growth numbers, for sure. However, its equity base was $130m, $202m, $220m, $232m, $252m, and (currently) $276m. That gives it an average pretax ROE of around 8% and ROIC of ~6.67%. Even if I add back in all of the costs for opening up new restaurants (about $6m each year), I still get average pretax ROE of ~11% and ROIC of ~9.5%. Not exactly Apple (AAPL) results there.
Using EBIT for Darden, I get $553m, $573m, $600m, $632m, and $644m and equity of $1.2b, $1.1b, $1.4b, $1.6b, and $1.9b. That gives average pretax ROE of about 42% and average pretax ROIC of around 20%.
So DRI is trading at a much lower multiple and has better returns on capital. But surely BJRI deserves a premium because it has a long expansion road ahead of it. While that statement is debatable, let's assume it’s true and look at BJRI’s history.
From 2004 to 2009, it increased operating income from $6.3m to $19.7m, a 26% CAGR; during that time, it had two equity raises that increased shares outstanding by 20%, and the equity capital certainly helped in the increase in income, but for our purposes here we’ll ignore that. Let’s assume it manages to earn $27m in operating income this year. If it manages to grow operating income at 26% for the next five years, it’ll make ~$85.7m in fiscal 2016 (five years from now). So assuming it manages to grow at the same rate it did for the past five to six years (during which time it did a large equity raise) for the next five years, it is currently trading at 11 times operating income five years from now. Contrast that to DRI, which currently trades for 12-13x operating income.
So which would you chose? The premier restaurant operator in the industry, with a history of prudent and profitable growth, trading at a reasonable valuation with a decent dividend yield, a large share buyback program, strong returns on capital, and several successful brands (including Olive Garden and Red Lobster)? Or a concept with one brand and a pretty small operating history, which trades at nosebleed valuations?